Life and Death Decisions
Many Factors Go into Choosing a Life-insurance Policy
“America is so underinsured,” he told BusinessWest. “The average American owns three or four times their salary.” This statistic was cited in an ad, run by the Life and Health Insurance Foundation for Education, that asked, “how long were you planning to be dead?”
“While that’s very flip — it was a pretty edgy campaign — it really does speak to the nature of the exposure that folks leave their families or businesses when they don’t have adequate life insurance,” said Bates, vice president of marketing at MassMutual.
But once someone gets serious about coverage, the question becomes, what kind? The answer first boils down to a choice between term or permanent life insurance.
The basic difference is that a term policy carries only a death benefit; when the insured party dies, it pays the face amount of the policy to the named beneficiary. Permanent life insurance, on the other hand, combines a term policy with an investment component that builds cash value that the policyholder can borrow against. Depending on how the policy is structured, proponents say, it’s possible to withdraw cash during one’s life even in excess of premiums paid.
“There’s really no ‘bad’ or ‘good’ life insurance,” Bates said. “Term and permanent are both good; they just serve different purposes. But permanent has, in addition to the death-benefit protection, a cash-accumulation component to it.”
He compared the two options to renting versus owning a home. “Term insurance is a lot like renting an apartment. The money essentially goes out the window every month, but it’s cheaper, and you’re probably not going to live there forever. Permanent insurance is more expensive, but affords the ability to build equity or cash value.”
Ginger Applegarth, an Arizona-based financial advisor, writes for MSN Money that “the wrong kind of life insurance can do more damage to your financial plans than just about any other financial product today.” But it’s not always an obvious choice.
“The saying you always hear is, ‘buy term and invest the difference,’ she notes. “The fact is, it depends on how long you keep your policy. If you keep the permanent life policy long enough (and the market never fully rebounds), that’s the best deal. But ‘long enough’ varies, depending on your age, health, insurance company, the types of policies chosen, interest and dividend rates, and more. The reality is that there is not a simple answer, because life insurance is not a simple product.”
That said, permanent life insurance carries more expensive premiums than term life, so the choice often comes down to a purchaser’s stage of life and finances, and “there’s no one-size-fits-all, that’s for sure,” said Jeffrey Siegel, vice president at United Wealth Management Group in Northampton.
“If a young husband and wife come to me and want to purchase insurance and they just got their first mortgage, maybe they’ll get a term policy that will cover 30 years, so they can make sure their mortgage is paid off” in case of one partner’s death, he noted. “With an older couple, maybe there are estate-tax issues, or it’s a second-marriage couple looking to make sure their children from outside the marriage are taken care of without going through a will or estate. Insurance is valuable, but a lot depends on what’s done with it.”
For this issue, BusinessWest examines the question of term versus permanent life insurance — and why the answer is far from simple.
Perm or Term?
Permanent life insurance takes three basic forms: whole life, universal life, and variable life. Whole life offers the most guarantees, from cash value to the death benefit. In most cases, the dividends they earn can be used to increase the cash value and/or death benefit, decrease the premiums, or be refunded in cash.
Universal life insurance is more flexible than traditional whole life, because premiums can vary from year to year and sometimes can even be skipped. Universal life offers maximum guaranteed premiums and minimum guaranteed cash values and death benefits. Instead of dividends, universal-life policies earn interest at the credited interest rate determined each year.
Finally, variable life insurance has the fewest guarantees and therefore offers the greatest potential for cash-value increases. There are required guaranteed annual premiums and a guaranteed minimum death benefit. However, there is no guaranteed cash value, and the policy holder must select the investments.
Peter Novak, general partner at Charter Oak Insurance and Financial Services, an agency of MassMutual, says his parent corporation specializes in whole life. He cited several reasons why this makes sense.
“Say I’m married, and I have two young children. When my son or daughter turns 18 and needs a car, looking at the environment today, if you’re a normal consumer, you go to the bank and say, ‘I need to take out a loan.’ It’s pretty difficult right now; a lot of paperwork needs to be done,” he explained. “But all I need to do is call MassMutual and take out a loan on my policy. That money that is loaned, I pay interest on the loan, but MassMutual credits me in dividends even on the money that I loaned. I need to have the discipline to pay the loan back, but it’s a much easier, smoother transaction to do it that way.”
The process works the same in place of a home-equity loan, or to perform needed repairs on a home in case of damage — for example, after Hurricane Sandy, to name one real-life scenario.
“We have clients down on the Connecticut shoreline who are waiting for their insurance payment to come through,” he said. “If they borrow on their policy at a short term, they can get their project done and wait for the insurance check to come.”
Novak said he has heard many such stories of people accessing needed funds thanks to their whole-life policy. “People are looking for guarantees right now.”
Applegarth emphasizes the difference in premium cost between term and permanent life insurance, but added that “the debate is all about that cash value.
“If you buy a policy today, your first annual premium is likely to be much higher for a permanent life policy than for term,” she explains. “However, the premiums for permanent life stay the same over the years, while the premiums for term life increase. That extra premium paid in the early years of the permanent policy gets invested and grows, minus the amount your agent takes as a sales commission.”
The key, she notes, is how long a buyer plans to keep the policy. “If the answer is less than 10 years, term is clearly the solution. If it is more than 20 years, permanent life is probably the way to go. The big gray area is in between. Here is where you need an expert to run the term versus permanent analysis for you.”
Bates agreed that professional assistance is important.
“For most folks, there are two steps in the insurance-acquisition process,” he said. “The first question is, how much do I need? They have a financial responsibility to their loved ones to get that question right. Once they have an answer to that question, then and only then should they think about what type of product they should be getting.”
Added Novak, “from a simplistic perspective, term insurance often applies to younger couples with a limited budget. But individuals who need life insurance and also have money for savings need to make a choice.”
Siegel, who spent 25 years as an estate-planning attorney, takes a different tack than those who emphasize the value of life insurance as an investment.
“As an estate planner, I tell people we have a lot of different tools in our toolshed, and I’ve always used life insurance as one of those tools. It depends on what the problem is or the issue is, and what needs to be done,” he told BusinessWest. “But, for the most part, we take the position that you buy term and you invest the difference.”
One reason, he said, is the unrealistic assumptions sometimes made about the value of a life-insurance policy. “There are a lot of old life-insurance policies out there that don’t have cash value anymore.” Siegel also said that certain unexpected rules and taxes may come into play about how cash may be drawn from a life-insurance policy.
But Bates said permanent life insurance is seeing a surge in popularity partly due to the challenged investment landscape of the past few years.
“Rewind the tape back to 2008, and everyone’s retirement accounts got hammered. The only folks seeing stable statements every month were those that owned whole life,” he said. “This environment has given a renewed interest and a conversational tailwind to the whole idea of using whole life as a versatile financial asset, particularly to help fend off times of market instability.”
That hasn’t always been the case, he added. “Whole life has been around maybe 150 years, but it goes through cycles of popularity. In the late ’80s and early ’90s, with double-digit interest rates, we were selling whole life into a headwind. We still sold it, though; people bought it because they realized the market doesn’t go up forever, and that component of people’s long-term financial strategy provides a keel to their sailboat.”
Those who choose whole life have many different reasons for doing so, Bates noted. Younger individuals and couples may want the ability to supply a cash flow for education or other family needs, while older people are thinking about the kind of life they want to live in retirement and what they want to leave behind.
“The reasons people buy it in their 30s is not the same as the reasons they keep it in their 70s. That speaks to the versatility of the product. It does so many things over the course of a person’s lifetime that no other single product can do.”
Novak agreed. “In this economy, people have been making a choice to pay a whole-life premium to get the cash value. If I was looking for something that could take care of my life needs, I’d put my money in a whole-life policy for its long-term guarantees. It becomes a very nice opportunity for the right person, and it can be very attractive in these volatile times.”
One thing is for sure: some form of life insurance is crucial, yet too many people still haven’t realized it. Siegel recalled something one of his mentors said when he heard someone say they didn’t “believe” in life insurance.
“Insurance is not a religion,” he said. “It’s something you have to use at certain times in your life.”
Joseph Bednar can be reached at email@example.com